RBI takes new steps to prop up rupee

By Neha Dasgupta and Suvashree Dey Choudhury

REUTERS - The Reserve Bank of India took new steps on Tuesday to support the rupee, signalling it will stay the course with its defence of the currency despite the risks to economic growth.

The central bank tightened liquidity further and made it even harder for lenders to access funds with measures including lowering the amount banks can borrow or lend under its daily liquidity window.

The latest moves come a week after its initial steps steadied the rupee somewhat, but left the currency still within sight of a record low of 61.21 hit on July 8.

However, bond yields - especially shorter-term rates - have surged, threatening to raise borrowing costs for banks and companies and sparking concerns about the impact on an economy growing at a decade low of 5 percent a year.

These worries, combined with a record high current account deficit and now uncertainty over the central bank's monetary policy stance, have prompted foreign investors to sell $11.5 billion of Indian debt and equities since late May.

The RBI is intervening more frequently in spot markets, traders said, coming in late in the session or whenever the rupee threatens to break below 59.89, the level at which the currency traded before the RBI's initial measures on July 15.

The central bank's steps, though meant to be temporary, are a clear indication of its renewed focus on financial stability, putting a monetary easing campaign intended to revive growth on hold.

"These measures of trying to reduce domestic liquidity and making funding costs higher may not be very effective to support the rupee," said Siddhartha Sanyal, chief India economist at Barclays.

"There is a risk that capital inflows in the equity market can get dented as these steps put more pressure on growth in the medium term," Sanyal said.

The RBI on Tuesday lowered the overall limit for borrowing under the daily liquidity adjustment facility (LAF) - which offers funds in exchange for collateral - for each bank to 0.5 percent of deposits from 1 percent.

The central bank also said banks now needed to maintain 99 percent of their daily cash reserve ratio requirements - the deposits they must set aside - with the RBI, compared with 70 percent now. The change takes effect from the two-weekly period starting July 27.

The RBI also announced the sale of 60 billion Indian rupees of short end cash management bills to drain out more cash from the banking system.

UNDER PRESSURE

The rupee has risen only 0.2 percent since the RBI's unprecedented steps last week to try to create demand for the currency by aggressively draining cash from money markets and sharply raising short-term interest rates.

However, bonds yields have surged across maturities, with 10-year benchmark bond yields up 62 basis points since the RBI's initial measures.

The Indian government is also contemplating steps to plug its current account deficit, including raising money from non-resident Indians (NRIs) via debt or deposits, according to senior government officials on Monday.

Still, the government has also made clear all options to support the rupee are on the table.

Continued falls in the rupee - down more than 10 percent since May partly in a reflection of a broader selloff in emerging markets - could prompt stronger measures either from the RBI or the government.

The RBI may intensify its efforts to drain liquidity and may even resort to an outright hike in the policy rate, analysts said.

The central bank holds its next policy review on July 30.

($1=59.8 rupees)

(Writing by Rafael Nam; Editing by John Stonestreet/Ruth Pitchford)